One cheer for fiscal cliff deal

The fiscal cliff deal isn’t all bad.

The country now has, for the most part, a tax code that can only be changed through congressional action rather than inaction. That’s a big step forward.

President Obama got his leverage in the fiscal cliff wrestling match from the fact that if Republicans didn’t agree to increase taxes on the affluent, taxes on everyone would go up. That leverage is now gone.

It was unfortunate that the price of a tax code without an expiration date was increasing the top marginal tax rate on wage income to around 40 percent and on investment income to 20 percent. This will not produce the revenue projected and will cause the affluent to deploy their resources in less economically productive ways.

But it was a price worth paying. Economic actors can now make decisions with some modicum of certainty in calculating prospective after-tax returns. As we’ve seen, getting Congress to act is tough. But it is really good at not acting. Having virtually the entire tax code subject to significant change if Congress does nothing was an economically unproductive place to be.

Some on the right believe that if congressional Republicans had stood their ground, Obama would have blinked and agreed to a one-year extension of all the Bush tax cuts, including those for the affluent. But economically, it is better to have these rates without an expiration date than lower rates at the top end with the entire code expiring again in a year.

The real lesson to be learned from the outcome of the wrestling match, however, is that this president and Congress aren’t going to do anything substantive to reduce debt and deficits until forced to do so by external events. There’s really no point in hoping for anything better from the upcoming scheduled wrestling matches over the debt ceiling and the continuing resolution for this year’s spending that expires in March.

The fiscal cliff deal represents a political consensus about taxes. In a healthy economy, that tax structure can be expected to produce revenues of about 18 percent of Gross Domestic Product, roughly the post-World War II average.

President Obama, however, proposes ongoing spending of around 22-23 percent of GDP. That would leave a chronic gap, even with a healthy economy, of 4 to 5 percent of GDP, well beyond the 3 percent economists generally think sustainable.

The country has an intermediate and a long-term debt problem. Accumulated debt now exceeds 100 percent of GDP, beyond the 90 percent threshold economic historians think represents the danger point. And last year’s annual deficit exceeded 7 percent of GDP, well above the sustainability threshold.

The intermediate problem is the need to get these numbers back into the safe zone as quickly as possible.

The longer term problem is reforming retirement programs – principally Social Security and Medicare – to comport with the reality of a declining ratio of workers to retirees. Baby Boomers are going to have to get less than current law provides for retirement income and health care or they will severely crimp the economic prospects of their children and grandchildren.

Addressing the intermediate and long-term debt problems requires an entirely different mindset than exists in Washington. Simply put, it can’t be business as usual when it comes to spending.

But it was business as usual with the fiscal cliff deal. In addition to raising taxes on the rich, it increased spending for unemployment compensation, even though we are supposedly a few years now into a recovery. Subsidies for green energy were extended. Several narrow interests were showered with special tax breaks.

It was business as usual with the bloated, pork-laden Sandy relief bill. And then House Speaker John Boehner got barbequed for daring to suggest that the thing be looked at with an eye to separating out what was truly emergency response spending.

Republicans have proposed some things that would actually reduce spending. But for the most part, both sides are instead wrestling about how much to promise to cut in the future, promises that are never kept.

At present, the federal government can borrow limitless sums of money at low interest rates. My guess is that until that changes, the mindset in Washington won’t.

(column for 1.4.13)

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